The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Monday, November 5, 2012

As reported by Bloomberg, a Danish bank was closed because of the losses hidden on its balance sheet even though it was reporting a profit and passing regulatory stress tests.

Regular readers know that banks need to be required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, market participants can independently assess the risk of each bank and adjust their exposure to the bank to reflect this risk.

Denmark’s latest regional bank failure shows that even lenders that had reported growing profits can conceal risks big enough to shut them down.

Which raises the interesting question of why did they shut this particular bank down? Clearly, it was not Too Big to Fail.

However, why did it need to be closed as banks in a modern banking system can operate with zero or negative book capital levels?

Toender Bank A/S (TNDR), based in southwest Denmark close to the German border, was forced to declare bankruptcy after markets closed on Nov. 2, following an inspection by the Financial Supervisory Authority that revealed bad loans big enough to wipe out the lender’s equity.....

Denmark’s burst housing bubble has claimed more than a dozen regional lenders since 2008 as continued declines in property values and a struggling farming industry trigger deeper impairments. About 3.2 percent of the nation’s roughly 105 banks are under “intensified supervision due to potential solvency problems,” FSA Director Ulrik Noedgaard said last month.

Until last week, Toender Bank had appeared profitable.

“Based on what the FSA had published, Toender Bank had until now looked fine and therefore it had not been subject to a lot of scrutiny,” Jesper Berg, senior vice president and head of regulatory affairs at Copenhagen-based Nykredit A/S, Europe’s biggest issuer of covered bonds backed by mortgages, said in an e-mailed reply to questions. “Reality turned out to be less benign.”....

There is no excuse for hiding reality from any market participant with an exposure to a bank.

By definition, every exposure to this Danish bank was mis-priced as no market participant other than the regulators had the information to know what the true risk of the bank was.

In its six-month report, published Aug. 21, Toender Bank reported writedowns of 32.5 million kroner and a net income of 9.2 million kroner, more than three times the profit posted a year earlier.

The bank, which has an ad on its website inviting prospective customers to a free dinner to entice them to open an account, claimed its solvency ratio was 17.3 percent at the end of June....

Showing what a bank will represent its current condition to be if it is not required to provide ultra transparency.

Actually, it should highlight the simple fact that the Danish financial system should not be dependent on the FSA as the sole provider of oversight.

By requiring the banks to provide ultra transparency, all market participants can provide oversight and not be dependent on the FSA.

Given the information now available, it appears Toender Bank’s management demonstrated “severe negligence” in its handling of the bank’s affairs, the Danish Bankers Association said in a statement late yesterday. There had been no indications that the bank might be facing insolvency, the association said.

The bankers group also criticized Toender Bank’s decision to sell 30 million kroner in hybrid capital to 460 customers in September.

“Everything points toward a failure of management that is indefensible but that is hard to protect against,” Joergen A. Horwitz, the director of the bankers association, said in a statement....

Actually, it is quite easy to protect against if the banks are required to provide ultra transparency.

With this information, market participants do not have to rely on bank management or the FSA's representations, but can independently assess the bank's exposures.

“I think Toender Bank is an outlier, but I wouldn’t rule out that a few other banks could face closure,” said Berg, who is also a former departmental head at the Danish central bank....

Without requiring banks to provide ultra transparency, there is no way of knowing which banks are solvent and which are not. Like Mr. Berg, market participants are left to guess.

A number of Denmark’s regional banks are still struggling.

About a quarter of Danish banks don’t generate enough core earnings to cover average industry writedowns as the cost of holding deposits grows, the FSA estimates....

Eighteen Danish banks had core Tier 1 capital ratios below 9.5 in the second quarter, while five were below 7 percent and one didn’t meet a 4.5 percent threshold, according to the regulator. As lenders continue to struggle, the FSA is setting more rigorous rules. It estimates that half of Denmark’s banks now face higher solvency requirements under a new model.

“The Danish FSA has recently tightened its provision rules and also applies some of the toughest capital standards in Europe, in particular through its very aggressive Pillar II practice,” Berg said. “The upside of this policy is that it should be possible to find buyers, who are also willing to take over all non-subordinated liabilities. The downside is that it can be tough on shareholders and subordinated creditors. That is likely to be a general trend in Europe.”

This suggests that there are a number of Danish banks that are representing they are solvent when in fact they are not. The question is which banks are they?

If Denmark wants to clean up its financial system it will require its banks to provide ultra transparency.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.